S&P's Fumbles Have to Make You Wonder

Was Standard & Poor's right to downgrade America's credit rating on Friday? We asked our readers this morning. They answered, by a convincing margin, yes.

It's hard to disagree. S&P's rationale for the downgrade is difficult to refute:

The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy.

Treasuries are, financially, still the safest form of debt in the world. The United States has the resources to pay its debt. This is not a question. What's worrisome is whether political leaders will threaten the viability of that debt to make a political point. And as last week showed, they are not only willing to, but they'll also do it again. As Sen. Mitch McConnell remarked, the debt-ceiling debate "set the template for the future" and added: "In the future… no president -- in the near future, maybe in the distant future -- is going to be able to get the debt ceiling increased without a re-ignition of the same discussion of how do we cut spending and get America headed in the right direction." That may be admirable in the mission to cut future deficits, but it's disastrous in the mission to remain creditworthy. That's why S&P issued a downgrade.

But there's more to the story. S&P's original report delivered to the Treasury on Friday contained a large math error. It doesn't dispute the mistake, and it quickly published a revised version, effectively claiming that the error was negligible in the grand scheme of things.

But as Ezra Klein of The Washington Post points out, the changes between the original and the revised report might not have been trivial. Says who? Well, says S&P itself:

In both versions of the report, Standard [&] Poor's say they would upgrade our outlook from "negative" to "stable" if the Bush tax cuts for income over $250,000 expire. That would net the Treasury about $900 billion over 10 years. So according to S&P, $900 billion is a big deal. And it's a big deal because of how much it would do to reduce the deficit.

In the original version, they say that $900 billion would mean net public debt drops from an estimated 93 percent of GDP in 2021 to 87 percent of GDP. But in the second version of the report -- the one they wrote after they discovered their $2 trillion mistake -- they revised their estimate for America's baseline debt path down to "74% of GDP by the end of 2011 to 79% in 2015 and 85% by 2021." In other words, S&P's technical correction improved our deficit outlook by more than letting the high-end tax cuts expire, which S&P had said would raise enough money to stabilize our rating. If the numbers mattered, then by S&P's own logic, that should have changed their opinion of our finances.

You don't have to agree with the logic of letting tax cuts expire. And S&P's final rationale for the credit cut -- political hostility -- remains as valid as ever. But the errors and updates bring a serious question to light: If S&P's math had been accurate the first time around, would it have gone through with the downgrade at all? By S&P's original analysis, one might believe the answer is no.

Today's stock market route showed how the downgrade affects nearly all of us, and potentially in huge, life-changing ways. Demanding that S&P's decision live up to its own standards isn't asking much.

What do you think? Share your thoughts in the comments section below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter, where he goes by @TMFHousel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (9)

Comments from our Foolish Readers

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  • Report this Comment On August 08, 2011, at 6:46 PM, SM0KY wrote:

    Playing brinksmanship with America's credit is another sign of Republican cluelessness. I guess it all comes back to the voters; we get the government we deserve. I understand that the Republicans only represent the wealthiest folks and the large corporations that get them elected (who's assets are global, and won't be hurt by our economy crashing), but who do the Democrats represent? A lot of middle class folks feel completely unrepresented. I am one.

  • Report this Comment On August 09, 2011, at 6:04 AM, Chemsoldier88 wrote:

    Smoky,

    What has happened to other world markets over the past 2 weeks while ours was going down? They were going down as well. If we go down, we will take others with us. Your philosophy is flawed.

  • Report this Comment On August 09, 2011, at 6:24 AM, The1MAGE wrote:

    People were complaining about annual deficits of a quarter of a trillion dollars during the Bush administration. Now we have had at least one month that reached that amount.

    The S&P is talking about $900 billion over 10 years, or $90 billion a year. (Sorry, simple math.) That only covers 11 days of deficit a year. And that assumes these tax increases will actually create more revenue, and that is not always a good assumption.

    A change in taxes results in a change in how people invest. The interest in tax free bonds may seem more promising then a taxable investment, and a taxable sale that may have occurred might be delayed until there is a change in the government, and tax rates.

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